Pfizer Bid: Move of Weakness Not Strength?

This leading pharmaceutical giant just made a considerably aggressive bid to buy another big drug provider, however, MoneyShow's Jim Jubak thinks this may be a sign of weakness, not strength.

Today it’s merger talk that’s keeping US stocks afloat.

The two big deals are General Electric’s (GE) bid for France’s Alstom ((ALSMY) in New York) and Pfizer (PFE) hostile bid for the United Kingdom’s AstraZeneca ((AZN) in New York) for $98.7 billion.

I can’t say I care for a market that’s counting on merger activity to make up for lackluster revenue and earnings growth. My experience is that this is a stage that indicates that an upward trending market has run out of fuel.

But investors and traders don’t seem to share my reservations today.

My favorite market quote this morning is this one from Gerhard Schwarz, head of equity strategy at Germany’s Baader Bank on Bloomberg: “Valuations have been the prime driver for equities for the last two to three years, but if we have an M&A frenzy, that would help keep valuations stable at these high levels.”

The market’s positive reaction to this bout of merger activity is especially puzzling to me because the Pfizer deal, today’s poster child for M&A, is so clearly a move of weakness rather than strength.

Pfizer is projected to show a compounded annual sales growth of just 0.5% over the next five years. (That’s low even for a big drug maker—Pfizer’s peers are expected to show annual growth of 2.4% according to Bloomberg.) AstraZeneca isn’t likely to fix that growth problem. The deal, instead, offers Pfizer chance to do some major financial engineering that will buck up earnings in the short-run and reorganize the company for future restructuring including a possible break up.

The $100 billion deal would let Pfizer use some of the $70 billion in cash from overseas earnings that it can’t repatriate to the United States without paying US taxes. After the deal, the combined company would be based in the United Kingdom through a holding company structure, which would lower the tax rate that US-based Pfizer pays currently.

As an exercise in financial engineering, the numbers make sense for Pfizer, but I can’t say that AstraZeneca strikes me as a great way to spend $100 billion. The combination would be the world’s largest health-care company by revenue—for a while. Astra Zeneca faces patent expirations that are likely to knock $2.5 billion off of sales by 2017. AstraZeneca faces the loss of patent protection in that period on Nexium and Crestor.

AstraZeneca does have a number of early stage cancer drug candidates that has either developed internally or acquired in an agreement with Immunocore, but if the goal is to acquire early stage drug candidates, buying AstraZeneca is a very expensive way to do it.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity
Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of Pfizer as of the end of March. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund’s holdings almost totally to cash.